Cheating on Diesel Emissions Brings Volkswagen to Perilous Crossroads

Volkswagen AG’s de facto admission that it cheated on US emissions tests for its signature clean diesel vehicles could be a devastating blow to the brand that has already been struggling in the American market while facing instability at the top in the form of CEO Martin Winterkorn’s seemingly tenuous hold on his job.

The consequences began cascading over the weekend and continued on Monday as Winterkorn apologized for breaking “the trust of our customers and the public.” Investors punished VW by sending the stock down nearly to three-year lows on the Frankfurt market, dragging the rest of Germany’s main stock index along with it. And a class-action suit on the part of American owners of VW models with Turbocharged Direct Injection (TDI) diesel engines already promised to materialize.

“There is no way to put an optimistic spin on this,” Max Warburton, an analyst with Bernstein Research, told the Wall Street Journal. “This is really serious.”

According to the US Environmental Protection Agency (EPA) VW allegedly rigged emissions tests for about 500,000 diesel cars by using a “defeat device” programmed to detect when the engines undergo official emissions testing. The device turns off the emissions controls during normal driving situations, allowing the cars to emit more than the legal limit of pollutants.

The challenges VW now faces are daunting. Winterkorn immediately halted the sale of all 2015 and 2016 models containing the four-cylinder, 2-liter TDI engine that is commonly found in Volkswagen Passat, Jetta, Golf, Beetle and in the Audi A3 luxury compact model. TDI vehicles comprise as much as one-fifth of Volkswagen’s vehicles sales, although their relative importance has eased lately given that lower gasoline prices have reduced the motive for many buyers to consider diesel.

Volkswagen has already been scuffling for the past couple of years after a three-year sales surge based on new products, including an Americanized version of the Passat sedan along with its new plant in Tennessee to make that vehicle.

Volkswagen may have to recall the TDI vehicles, either voluntarily or by force. What isn’t clear yet is what the company and its dealers would do with the recalled cars.

The EPA indicated VW also faces fines that could run to more than $18 billion. The final number is likely to be way lower than that as regulators and Volkswagen negotiate a deal, but it seems possible the amount could trump the huge $900 million agreed to last week by General Motors to settle the case of its defective ignition switch and the more than $1 billion in fines Toyota paid in its unintended-acceleration debacle from several years ago. It also seems possible that someone at Volkswagen could eventually end up facing criminal actions, such as those settled by GM as part of its agreement with the federal government.

Winterkorn could personally end up paying a price for this episode, even if he was unaware that engineers might have been fudging emissions tests. He survived a recent challenge to his leadership resulting from a power struggle with his former mentor and VW chairman, Ferdinand Piech, forcing Piech’s ouster from Volkswagen AG. Part of Piech’s critique of Winterkorn was his inability to get the VW brand to the next level in the crucial US market. Now Winterkorn faces a previously scheduled vote on Friday by the VW supervisory board on renewing his contract.

A number of factors will determine VW’s ultimate fate in the US market.

One of them is the relative seriousness of VW’s alleged violation which, Automotive News argued, “stands out in its brazenness” compared with “other run-ins between the EPA and automakers.” Those include recent episodes in which both Ford and Hyundai-Kia had to reduce the fuel-economy ratings on some vehicles under EPA pressure.

Will American consumers penalize Volkswagen for allegedly attempting to pull the wool over their eyes? And will potential buyers perceive VW’s offense to be on the same level as the safety dangers posed by GM and Toyota in their recent offenses?

On top of those, consider the impact this news could have in Europe, where Volkswagen AG and its many brands dominate huge swaths of the auto business, and where diesel power is by far the most common form of propulsion. VW risks not only the wrath of and fines from European regulators but also a potentially ruinous backlash by European consumers who have come to count on clean diesel to be as “clean” as advertised.